What is inflation and how can it affect the currencies we trade?

If the average price of the economy’s goods and services increases over a period of time and the purchasing power starts to decline, inflation is happening. In layman’s terms, inflation is when the purchasing power of money decreases while the prices increase.

Tell me more about inflation.

Humans have the necessities to live and make a living. There are quite a handful of them if we name them one by one. For instance, people need to have commodities like food grains, fuel, metals, etc. People also need shelter, utilities, transportation, healthcare, and many more. Here is where inflation enters the picture. It helps us know and measure the impact of all the things we mentioned if their prices changed. Hence, a single value can represent the economy’s goods and services prices as a whole in a given time frame. The opposite of inflation is deflation. It happens when the prices of goods and services decrease, and the inflation rate is lower than 0%.

The economy and the purchasing power

Central banks and economies exert their best efforts when it comes to managing the supply of money and credit so that inflation will not go into an uncontrollable and extreme level. They need the economy to run smoothly. Inflation has both its pros and cons. It is benefits borrowers because when the money’s real value decreases, their debt becomes less. On the side of consumers, if the currency loses or falls in value, the price will increase. Hence, the currency buys fewer goods or services. It is like a domino effect. A decline in purchasing power means a change in the cost of living in that specific country. This situation will slow down economic growth.

What can cause inflation to happen?

If we think about it, a massive supply of money may be the root cause of inflation. How? Monetary authorities can print more money and give those away to people. They can reduce the value of a legal tender currency in purpose and legally. The most common cause is making new money loans to become reserve account credits. It is made possible by the banking system when buying government bonds from financial institutions like banks on the secondary market.

Everything we have mentioned contributes to the increase in money supply, decreasing money’s purchasing power. There are three popular mechanisms on how the things we said turns into inflation:

  • Demand-pull effect. The money and credit supply increase triggers the increase of goods and services demand which is much faster than the economy’s production capacity. It results in both increases in demand and price.
  • Cost-push inflation. Price increases because of additions in money and credit supply channeled into commodities or other assets. Negative economic shock to the significant commodities supply aggravates the impact. In layman’s terms, cost-push inflation happens when additional inputs in the production process result in a price increase.
  • Built-in inflation. This is when people expect that the current inflation rates will not go any time soon.

Is it a good time to trade when there is inflation?

Any time is an excellent time to trade if you know how to take advantage of the situation—study and research before betting your money. Some great brokers can help you realize your potential in becoming more profitable. You just have to know which one.